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Read the Article THE C RITERION J OURNAL ON I NNOVAT I ON Vol. 4 E E E 2019 Component Valuation in Law and in Marketing Saul Levmore* Problems arise in evaluating a given variable when it is one of several that have combined to bring about a result. Imagine that you contract to buy a house and then the beautiful kitchen stove, one of many things that attracted you to the property, is destroyed before you close the transaction or occupy the property. How much should the price now be reduced? The market may provide an answer: here there is an upper limit based on the cost of a compa- rable replacement appliance. A more precise valuation would also be easy if identical houses, lacking this one feature, had recently been sold. The stove is just a piece of the larger transaction, and with these convenient facts, there is not much of a valuation problem. Additionally, the stove is unlikely to have been of greater value because of its interaction with other items in the house; colors and sizes are fairly standardized. “Conjoint analysis”—a term that usually refers to survey evidence that tries to elicit the value of a compo- nent—is therefore unnecessary, or at least uncomplicated, because value does not depend on an interaction among variables in a way that is not directly observed. In contrast, consider a patent case concerning a company that adds three components, ABC, to a product in order to fetch a higher price and capture a larger market share. It turns out that the use of A knowingly infringed on the patent of another. What are the damages owed to this patent holder? It would be convenient if the two parties had recently bargained for the right to use A and nearly come to an agreement, or if A were the only new feature in the product sold, instead of being combined with B and C. In these cases, we would have a good sense of the value of A to the breaching party or to the market. I aim to show that this component valuation problem in patent law is often like the “conjoint analysis” question in marketing research, a topic also discussed presently. I then show that it is also comparable to tort law’s * William B. Graham Distinguished Service Professor of Law, University of Chicago Law School. Email: [email protected]. I am indebted to Thomas Cotter and Jonathan Masur for discussions about Patent Law. Copyright 2019 by Saul Levmore. All rights reserved. 381 382 The Criterion Journal on Innovation [Vol. 4:381 difficulty in carrying out the doctrine of comparative negligence. Finally, I suggest that some solutions to the problem in one area might be useful, or hint at untried solutions, in another. Be forewarned that it is probably impossible to find a single, perfect solution that fits all cases in these but it is interesting to think that areas of law might be informed by the marketing literature, and vice versa. I. Patent Damages and Combinatorial Value A good starting point is Cornell University v. Hewlett-Packard Co.1 Cornell had a valid patent on a method for speeding up computer processing. HP infringed on Cornell’s patent by (profitably) selling a product that it knew included Cornell’s innovation without first acquiring Cornell’s consent. HP’s product combined the Cornell innovation, which we will call A, with non-Cornell advances in computer processing, which I will summarize as B and C. HP’s sale of the combination ABC generated large profits, though the court seemed skeptical that HP’s success had much to do with the presence of Cornell’s piece. Cornell, of course, objected and sought recovery in the amount of HP’s gain. A reader might imagine recovery aimed at deterring infringement and based on some “entire market value rule.” Let us think of it as Option 1, amounting to all the profit HP earned from these sales, nominally attributable to the ABC improvement and advantage over its competitors.2 In practice, however, patent law can be understood as attempting to recreate the value that the owner would have extracted from the infringer. After all, if Cornell and HP had bargained, it is the value of A to HP that they would have divided.3 A court might therefore give Cornell: (2) the amount of the profit attribut- able to the inclusion of A, or (3) an amount reflecting a guess as to how the parties (or perhaps typical parties) would have divided the profit attributable to A through contract negotiation. Option 3 is a fraction of Option 2. While Option 2 aims at the value of A somehow separated from BC, and certainly separated from HP’s larger product in which ABC was contained, it plainly 1 609 F. Supp. 2d 279 (N.D.N.Y. 2009); see also Elizabeth Bailey, Gregory Leonard & Mario Lopez, Making Sense of “Apportionment” in Patent Damages, 22 Colum. Sci. & Tech. L. Rev. 255, 259 (2011) (“In short, Judge [Randall] Rader identified the portion of the revenue of the overall product (the server) that was closely related to the patented technology, namely the processor, and then used that revenue as the royalty base.”). 2 Essentially, the entire market value rule allows compensation for the value of an item as-sold where the value for a patented component part is inseparable from the value of the whole. Cornell, 609 F. Supp. 2d at 286 (“When applied, this rule ‘permits recovery of damages based on the value of the entire apparatus containing several features, where the patent related feature is the basis for customer demand.’” (quoting State Indus., Inc. v. MorFlo Indus., Inc., 883 F.2d 1573, 1580 (Fed. Cir. 1989)). 3 See 35 U.S.C. § 284 (damages awarded for infringement shall be “in no event less than reasonable royalty for the use made of the invention by the infringer, together with interest”). In Cornell, damages were based on “the smallest salable infringing unit.” Cornell, 609 F. Supp. 2d at 287–88. 2019] Component Valuation 383 discourages patent infringements. This is because if HP had bargained for the right to use A, as reflected in Option 3, it would presumably have done better than giving all the marginal profit away. Such an intermediate recovery avoids giving Cornell undeserved credit for HP’s unobjectionable use of BC.4 It must be noted that finding the amount attributable to the inclusion of A is even harder than already suggested. Courts might want to reward the company that thought of combining the three elements, ABC. At times that innovator will be a patent holder like Cornell, but it is more interesting when it is a company like HP which might have taken A but never used A on its own, always ingeniously combining it with BC. For our purpose, it will be sufficient to recognize that Option 2 may be closer to Option 1 than it first seems, because courts might (learnedly or intuitively) upgrade Option 2 to a level we can designate as Option 4, at least when it seems appropriate to reward the innovative step taken by the apparent infringer in combining the patented element with other elements, whether they are patented or freestanding. Option 4 thus blends the conventional idea of marginal value (of A) with the value of combining it with other elements. In the litigated case, the court eventually imagined a royalty based on Option 2.5 Nevertheless, it is easy to be attracted to something approach- ing Option 1. There are several reasons for this sort of generosity to the infringed upon party. First, there is the difficulty of extractingA from ABC. Second, there is the difficulty of recreating the bargain that would divide the gain from innovation between Cornell and HP. And, most important, the prospect of high damages might be certain to deter the intentional taking of patented inventions. Still, it is important to see the danger of over-deter- rence, which threatens a party like HP with disaster if it innovates. HP may well have known of Cornell’s patent claim on A, but HP might have been uncertain about the legal viability of this patent, given that it could have considered Cornell’s contribution to be an unprotected idea rather than a process, machine, or article of manufacture.6 It is for this reason that I 4 A reader interested in additional information on damages in patent law, such as the “reasonable royalty” standard and infringement damages, might look to the analysis provided by Greg Allenby, Jeff Brazell, John Howell & Peter Rossi, Valuation of Patented Product Features, 57 J.L. & Econ. 629 (2014). 5 The decision is analyzed in Drew Voth, Patent Damages Apportionment and the Cornell Case, Counselor @ Law (Oct. 4, 2010), https://web.archive.org/web/20161013125619/http://www.wac6.com/ wac6/2010/10/patent-damages-apportionment-and-the-cornell-case.html. For some excellent discussion of the component valuation problem, see Allenby, Brazell, Howell & Rossi, supra note 4; J. Gregory Sidak & Jeremy O. Skog, Using Conjoint Analysis to Apportion Patent Damages, 25 Fed. Cir. B.J. 581 (2016); Gregg Allenby, Peter E. Rossi, Lisa Cameron, Jeremy Verlinda & Yikang Li, Calculating Reasonable Royalty Damages Using Conjoint Analysis, 45 AIPLA Q.J. 233 (2017). An innovation in this literature is the idea that when people are surveyed, they should compare an offering not just to an enhanced or narrowed item but also to items offered by other sellers. Another insight focuses on the difference between asking about the future compared to what would have happened in the past.
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